Despite a recent announcement by the US that it plans to delay an increase in tariffs on US$200bn-worth of Chinese goods, we still hold the escalation of rising protectionist sentiment turning into a full-blown trade war between the US and China as part of our baseline forecast. This is mainly because US demands for China to address contentious issues on technology transfer and intellectual property theft as part of trade negotiations make long-term progress towards an end to the trade conflict unlikely. However, beyond bilateral protectionism there remains a risk that trade conflicts will escalate on additional fronts in the coming years, to the extent that global trade could actually decline, with major knock-on effects for inflation, business sentiment, consumer sentiment and, ultimately, global economic growth. This scenario would be triggered if a number of countries were to decide to impose broad-based import tariffs and subsidise local industries in order to combat international protectionism. Although the US has renegotiated the North American Free-Trade Agreement (NAFTA) with Mexico and Canada, now known as the United States-Mexico-Canada Agreement (USMCA), some doubts remain over the long-term commitment of the US president, Donald Trump, to such a deal. Mr Trump has also threatened additional tariffs on imports of EU cars, which would result in a broader trade conflict as the EU attempts to defend its interests. Should the US and another major economy become embroiled in a full-blown trade war, and other countries also seek to protect their industries, we would expect global trade to shrink, inflation to rise, consumers' purchasing power to fall, investment to stagnate and global economic growth to slow.

Negative scenario—Supply shortages lead to a globally damaging oil-price spike

Moderate risk; High impact; Risk intensity = 12

After reaching four-year highs of over US$83/barrel in late September, the price for dated Brent Blend has plunged to about US$60/b, as the US has granted six-month sanction waivers to eight of the key purchasers of Iranian oil. Along with higher output from Saudi Arabia, this has alleviated market fears of supply shortages for now. However, the risk of major supply disruptions remains. Should the US manage to crack down efficiently on Iran's "ghost tankers" and also strike deals with other importers to switch their supplier bases away from Iran once the waivers have expired, Iran's oil exports could drop well below the 1.2m barrels/day (b/d) that we currently expect in 2019-20. To combat this, Saudi Arabia and Russia have the capacity to ramp up supply—as evidenced by their combined 250,000-b/d increase in output in September. However, as spare production capacity is used up to cover Iranian cuts, there is a growing risk that a sudden and sizeable cut to supply elsewhere—particularly in volatile countries such as Libya and Venezuela—would lead prices to soar to about US$100/b, with producers unable to increase output sufficiently to put a lid on price rises. Such a scenario would push up inflation, weighing on global growth.

Many emerging markets have suffered currency volatility in 2018, primarily as a result of US monetary tightening and the strengthening US dollar. In a few instances a combination of factors, including external imbalances, political instability and poor policy-making have led to full-blown currency crises. However, the major damage has thus far been restricted to economies with heightened country-specific weaknesses, such as the geopolitical tensions and lack of credible monetary policy in Turkey, and the sizeable external and fiscal deficits in Argentina. Moreover, the primary influence continues to be the attractiveness of rising US interest rates and equities rather than widespread risk aversion to emerging markets, as evidenced by differentiated outflows from these economies. The pressure on emerging markets as a group could intensify if market sentiment deteriorates further than we currently expect. One trigger for this could be if a number of other major emerging markets were to fall into crisis. For example, although Brazil's external debt is low, it is still vulnerable to renewed concerns about public debt sustainability, should policy take a populist turn following the recent election of Jair Bolsonaro as president. Alternatively, investors could flee emerging markets if the recent currency crises in Argentina and Turkey escalate into full-blown banking crises as the rising value of foreign-currency debt leads to defaults (this is not our central view). In this scenario, capital outflows from emerging markets would become more indiscriminate and severe, forcing countries with external imbalances to make painful adjustments, with the most vulnerable falling deep into crisis. Emerging-market GDP growth would fall sharply as a result, weighing on the global economy.

As well as proving vulnerable to trade war concerns, global stock markets have been sensitive to potential shifts in monetary policy. Our central scenario is currently that US monetary policy will become more cautious in 2019, with inflation picking up only modestly and growth slowing. This view is largely built in to financial markets. However, there remains a risk that US inflation could accelerate faster than currently expected. The latest jobs data from the US show nominal wages accelerating by 3.1% year on year in November, with the economy close to full employment. Although this remains below peaks in wage growth during previous business cycles, the combination of rising wages and expansionary fiscal policy, and the threat of rising import tariffs mean that inflation could start to accelerate beyond the current projections of the Federal Reserve (Fed, the US central bank). In response to this, monetary tightening by the Fed would accelerate, outpacing market expectations. In this scenario, risks to the global economy would come from two key areas. First, financial markets would experience heightened volatility, with collapsing investor sentiment causing widespread sell-offs, particularly in emerging economies. Second, interest rates would probably rise globally in response to the Fed, leading to a slowdown in global economic growth, including in developed economies.

In China a shift towards looser macroeconomic policy settings is under way as a result of the escalating trade conflict with the US. This will support domestic demand in the short term, but in the process previous goals of lowering unsold housing stock and corporate deleveraging are receiving less emphasis. There is a risk that, in the government's efforts to support the economy, policy missteps are made. The stock of domestic credit remained at over 230% of GDP at the end of the third quarter of 2018, a major vulnerability. Although it is likely that the authorities would make every effort to prevent a funding crunch in any bank, even a hint of banking sector distress could cause problems, given the boom in debt over recent years. Resolving these issues, particularly as the trade conflict with the US also weighs on economic activity, could prove challenging, forcing the economy into a sudden downturn. The bursting of credit bubbles elsewhere has usually been associated with a sharp deceleration in economic growth and, if this were accompanied by a house-price slump, the government might struggle to maintain control of the economy—especially if a slew of Chinese small and medium-sized banks, which are more reliant on wholesale funding, were to falter. If the Chinese government is unable to prevent a disorderly downward economic spiral, this would lead to much lower global commodity prices, particularly in metals. This, in turn, would have a detrimental effect on the Latin American, Middle Eastern and Sub-Saharan African economies that had benefited from the earlier Chinese-driven boom in commodity prices. In addition, given the growing dependence of Western manufacturers and retailers on demand in China and other emerging markets, a disorderly slump in Chinese growth would have a severe global impact—far more than would have been the case in earlier decades.

Negative scenario—There is a major military confrontation on the Korean peninsula

Low risk; Very high impact; Risk intensity = 10

There has been a pick-up in diplomatic activity on the Korean peninsula in 2018, peaking with a historic summit in June between Mr Trump and the North Korean leader, Kim Jong-un, in Singapore. Decades of carefully planned approaches between the US and North Korea have failed, and there is a glimmer of hope that a more improvised tactic by two unorthodox characters could make progress. However, we maintain the view that there are irreconcilable differences between the US and North Korea on both the pace and the breadth of denuclearisation. Although recent statements by the US Department of State have hinted at a slight easing of demands for complete, verifiable and irreversible denuclearisation by 2020—the end of Mr Trump's term—US goals nevertheless remain significantly at odds with the North's long-term commitment to its nuclear programme. Any realistic denuclearisation (which would be a step-by-step programme) would require 10 20 years of sustained engagement. Such levels of bilateral trust are unlikely to be achieved under the current administration. Our core forecast is that the US will eventually be forced to revert to a containment strategy. However, should the diplomatic talks fall apart, the Trump administration could see this as justifying a more aggressive stance, including strategic strikes on the North. This option has been publicly favoured by some of Mr Trump's close advisers, such as John Bolton, the national security adviser, who was at the summit on June 12th with Mike Pompeo, the secretary of state. Under such a scenario, North Korea would almost certainly retaliate with conventional weaponry and, potentially, short-range nuclear missiles, bringing devastation to South Korea and Japan, in particular, at enormous human cost and entailing the destruction of major global supply chains.

Negative scenario—Proxy conflicts in the Middle East develop to disrupt global energy markets

Moderate risk; Moderate impact; Risk intensity = 9

The rivalry between Saudi Arabia and Iran has been a multi-decade issue, further stoked by the US's withdrawal from the Iran nuclear deal, which has empowered hardliners in the Islamic Republic. In addition, Israel has long viewed Iran as its biggest threat in the region, although this hostility has played out in confrontations with proxy groups such as the Lebanese Shia group, Hizbullah. However, there is a rising risk of outright conflict in the coming years as the wider region becomes more polarised. Historically, Saudi Arabia's geopolitical actions in the region have been cautious and reactive. But in the light of the perceived threat from an expansionary Iran, combined with a much more assertive younger generation of policymakers led by the crown prince, Mohammed bin Salman al Saud, Saudi Arabia has become more aggressive. The crown prince has led a military intervention in Yemen since 2015, and has participated in a boycott of Qatar since June 2017. Both moves were partly an attempt to crack down on Iranian influence. Saudi Arabia has also been emboldened by US policy in the Middle East. Any country in the region with conflicting interests in the rivalry between Iran, Israel and Saudi Arabia is likely to suffer from a destabilising proxy conflict in the medium term through either indirect military action or the funding of competing political groups. For the global economy, the biggest threat is that these proxy battles lead to wider conflict in the Gulf region, pitting Saudi Arabia and/or Israel against Iran, causing significant volatility in global oil and gas markets, and hurting global growth prospects.

Negative scenario—Cyber-attacks and data integrity concerns cripple large parts of the internet

Moderate risk; Moderate impact; Risk intensity = 9

Public, corporate and government faith in the internet as a source for global good is under strain. Revelations of major data breaches across a range of social media, and the use of that data for propaganda, are likely to see social media companies facing tighter regulation in the coming years. Meanwhile, cyber-attacks continue apace. In March the US blamed Russia for a cyber-attack on its energy grid. At a similar time there was a sustained attack on German government networks. Although these attacks have been relatively contained so far, there is a risk that their frequency and severity will increase to the extent that corporate and government networks could be brought down or manipulated for an extended period. Cyber-warfare covers a broad swathe of varying actors, both state-sponsored and criminal networks, as well as differing techniques. Recent data breaches and cyber-attacks could well be part of wider efforts by state actors to develop the ability to cripple rival governments and economies, and include efforts to either damage physical infrastructure or gain access to sensitive information as a means to influence democratic processes. These breaches of security have shaken consumer faith in the security of the internet and threaten to put at risk billions of dollars of daily transactions. Were government activities to be severely constrained by an attack, or physical infrastructure damaged, the impact on economic growth would be even more severe.

Negative scenario—Territorial or sovereignty disputes in the South China Sea lead to an outbreak of hostilities

Low risk; High impact; Risk intensity = 8

The national congress of the Chinese Communist Party in October 2017 was a milestone in terms of China's overt declaration of its pursuit of great-power status, setting the goals for China to become a "leading global power" and have a "first-class" military force by 2050. The president, Xi Jinping, is keen to develop China's global influence, probably sensing opportunity during a period of US retrenchment. How China intends to deploy its expanding hard-power capabilities in support of its territorial and maritime claims is likely to be a source of major concern for other countries in the region. In the South China Sea the sovereignty of a number of islands and reefs is in dispute. Several members of the Association of South-East Asian Nations (ASEAN) have sought to strengthen their own maritime defence capabilities amid increasingly aggressive moves by China to place military hardware on the disputed territories. A partial abdication of US leadership of global affairs is likely to embolden China to exert its claimed historical rights in the South China Sea. An acceleration of China's island reclamation measures or the declaration of a no-fly zone over the disputed region are distinct possibilities. There is also a risk that an emboldened Mr Xi will step up his government's efforts to unify Taiwan with mainland China, with the president having previously noted that the cross-Strait issue was one that could not be passed "from generation to generation". Were military clashes to occur over any of these issues, the global economic consequences would be significant, as regional supply networks and major sea lanes could be disrupted.

We assume that, once the Brexit negotiations have been resolved, the UK will withdraw from the EU's single market and customs union and will negotiate a free-trade agreement (FTA) with the EU during a 21-month transition period from end-March 2019. However, political deadlock in the UK on the terms of the withdrawal agreement negotiated between the UK and the EU has increased the risk that the UK leaves the EU in early 2019 without a transition period designed to allow time for the FTA to be agreed. We would expect this to trigger a sharp depreciation in the value of the pound and a much sharper economic slowdown in the UK than we currently forecast. In addition, the EU has indicated that under a "no deal" scenario it would treat the UK as a "third country", leading to tariffs, border checks and controls, a stance that the UK would probably respond to in kind. In this climate, uncertainty surrounding economic policymaking and internal politics would weigh heavily on investment. Although some contingency plans have been made, the hit to UK and EU trade and investment under a disorderly no-deal scenario is likely to go beyond just the negative impact on European economies, and prove sizeable enough to dent global economic growth.